Financial Market Analysis

Financial Market Analysis

Financial Market Analysis

Financial Market Analysis

Synopsis

The eagerly awaited second edition of this highly successful book has been greatly expanded from 400 to over 700 pages and contains new material on value at risk, speculative bubbles, volatility effects in financial markets, chaos and neural networks.
Financial Market Analysis deals with the composition of financial markets and the analysis and valuation of traded securities. It describes the use of securities both in constructing and managing portfolios and in contributing to portfolio performance. Particular attention is paid to new types of investment product, different portfolio management strategies, speculation, arbitrage and risk management strategies and to financial market failure.
Financial Market Analysis is an essential text for all finance-related degree courses at undergraduate, postgraduate, and MBA level. It also provides a useful source of reference for financial institutions and professionals in the financial markets.

Excerpt

Bonds are capital market securities and as such have maturities in excess of one year, unlike money market securities discussed in the last chapter which have maturities of less than a year. Bonds also have more intricate cash flow patterns than money market securities, which typically involve just a single payment at maturity. This makes bonds more difficult to price than money market instruments. It also makes these prices more responsive to changes in the general level of interest rates than is the case with money market instruments. Further, the day count basis in the bond market sometimes differs from that in the corresponding money market: the uk uses an actual/actual day count in the bond market but an actual/365 day count in the money markets. Most of the world's bond markets now use the actual/actual day count.

In this chapter we consider the following issues: different types of bond, the fair pricing of bonds, different yield measures, different yield curves (or term structures of interest rates), various theories underlying the yield curve, fitting the yield curve, and different measures of the interest rate risk, e.g. duration and convexity. We conclude with a discussion of floating-rate notes. the analysis of convertible bonds and bonds with warrants is deferred until Chapter 9.

5.1 Types of bond

There are many different types of bond that can be issued. the most common type is the straight (or plain vanilla or bullet) bond. This is a bond paying a regular (usually semi-annual), fixed coupon over a fixed period to maturity or redemption, with the return of principal (i.e. the par or nominal value of the bond) on the maturity date. All other bonds will be variations on this. the frequency of coupon payments can differ between bonds; for example, some bonds pay coupons quarterly, others pay annual coupons. the coupon payment terms can also differ between bonds. For example, some bonds might not pay coupons at all (such bonds are called zero-coupon bonds, and they sell at a deep discount to their par values since all the reward from holding the bond comes in the form of capital gain rather than income); some bonds make coupon payments that change over time, e.g. because they are linked to current market interest rates (variable rate bonds or floating rate notes) or to an index such as the retail price index (index-linked bonds); and some bonds make coupon payments only if the income generated by the issuing firm is sufficient (such bonds are known as income bonds; unlike other bondholders, an income bond-holder cannot put the firm into liquidation if a coupon payment is not paid).

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